Israeli Economy Braces for Downgrades and Tech Sector Weakness Amidst Judicial Reforms Turmoil
Israel’s economy is facing potential downgrades in ratings, a decline in foreign investment, and a weaker tech sector as a result of the government’s controversial judicial reforms, according to investors and analysts.
The government recently passed the first of several laws aimed at limiting the powers of Israel’s Supreme Court in favor of Prime Minister Benjamin Netanyahu’s executive branch. This move has sparked widespread protests, with workers from various sectors, including doctors and tech firms, joining forces in demonstrations. As a consequence, the shekel currency has dropped more than 2% against the dollar, totaling a decline of over 9% since the reform plans were first announced in January.
The prevailing uncertainty surrounding Israel’s economy is a significant concern for foreign investors. Hamish Kinnear, a senior analyst at Verisk Maplecroft, highlights the lack of a clear endpoint to the judicial reforms as a major issue. He suggests that until the uncertainty is resolved, it will hang over Israel’s economy as a question mark.
The turmoil has had a detrimental effect on Israel’s stock market, with the MSCI Israel index lagging behind global stock indices by approximately 14%. Despite this, foreign investment in Israeli equities remained strong until the end of June, thanks to the country’s compelling economic outlook. However, the potential for further civil unrest could deter incoming cash, warns Kinnear. Morgan Stanley has cautioned that if domestic tensions remain unresolved, Israel’s GDP growth could be limited to just 1.0% and 1.6% for this year and next, respectively, whereas previous forecasts predicted growth rates of around 2.5% and 3%.
Roger Mark, a fixed-income analyst at Ninety One, emphasizes that Israel is still an attractive investment opportunity but highlights the government’s pursuit of judicial reform as an undermining factor. Investors and ratings agencies had initially expected a dilution of the reform to a greater extent. With such expectations unlikely to materialize, investors may be cautious about engaging with the country’s bonds.
The government’s justification for the reform centers around the view that the Supreme Court has been overly interventionist and that its powers need curbing. However, the prospect of a direct conflict between the court and the government looms as the Supreme Court plans to hear an appeal against the judicial reform law in September. Kinnear warns of the potential for an immediate constitutional crisis, further fueling the uncertainties surrounding the economy.
Israel’s tech sector, which contributes almost a fifth of the country’s GDP, over half of its exports, and a quarter of income tax revenues, is particularly vulnerable to the upheaval caused by the reform backlash. The sector, known for its innovations in areas such as cybersecurity and artificial intelligence, has been the fastest-growing industry in Israel for more than a decade. However, a recent survey conducted by the Israeli Innovation Authority indicates that the uncertain business environment has led up to 80% of new Israeli startups to register overseas. Additionally, tech firm fundraising plummeted by 65% in the second quarter.
Nicholas Farr, an emerging Europe economist with Capital Economics, suggests that this reform backlash could permanently limit economic growth in Israel. Such concerns extend to the country’s credit rating, as all three major agencies—S&P Global, Moody’s, and Fitch—have already raised red flags regarding the government’s policy direction. Israel’s sovereign credit has been downgraded by Moody’s, while S&P predicts that the ongoing protests will hamper economic growth this year. Fitch has warned that the judiciary changes could weaken governance indicators, policymaking, and investor sentiment, negatively impacting the country’s credit profile.
Natalia Gurushina, the chief emerging market economist at VanEck, believes that the ratings or their outlooks might face downgrades due to the new laws. She highlights the potential institutional deterioration resulting from the reforms, which could affect capital inflows, especially in sectors such as tech.
The uncertainty caused by the judicial reforms is now threatening Israel’s economy and its thriving tech sector. While the government seeks to limit the Supreme Court’s power, protests, downgrades, and reduced investment pose significant challenges. The subsequent impact on GDP growth and credit ratings further underscores the need for resolution and stability in Israel’s political and judicial spheres.
